Today, we answer some of your common questions.
Questions like … How should your property investment strategy change given the current circumstances?
Should you still be focusing on capital growth for your investments?
How do you transition from the capital growth stage to the cash flow stage for your investments?
We’ll also talk about those 40-year spreadsheets and property strategy plans. Do they work, or is there a more effective property strategy plan?
People also want to know about how much of a financial buffer they need or whether diversification is the right move for them.
These are all good questions, and hopefully, my conversation with Kate Forbes will bring you some clarity.
How has Metropole changed what they buy given the current circumstances?
When you invest in property there are three major factors deciding where you buy and the type of property you buy:
- Your budget – and that is usually determined by the banks
- The location - we are not prepared to compromise on this because location will do 80% of the heavy lifting of your property
- The property you purchase. – It has to be the right type of property, one that’s going to outperform the averages with regard to capital growth.
We don’t change our strategies, which are long-term plans, due to the short-term fluctuations of the economy or property markets.
Why should I focus on capital growth over cash flow? Especially now when there is likely to be lower capital growth?
Despite what you’d like to believe, you just can’t live off the rents of your property.
In my mind the only way to become financially independent through property is to first grow a substantial asset base (by owning high-growth properties) and then transition to the next stage – the cash flow stage – by lowering your loan to value ratios. In other words, reducing your debt, but not paying it off completely.
Remember the 3 stages of wealth creation I’ve mentioned before
- The asset growth – this requires leverage
- Transitioning to lower LVR - where you slowly pay down your debt
- Living off the Cash Machine of your property portfolio
How are you going to repay all your loans before you retire?
An ideal situation would be to own a mixture of growth and income-producing assets that looks a little like this:
- You would own your own home with no debt against it
- You’d have a substantial superannuation fund which should be delivering you a regular income
- You would own a multimillion-dollar property portfolio which is no longer negatively geared and, if it does have debt against it, the LVR would be such that the portfolio generates income. This would not need to be a lot of income but needs to be sufficient so that your property portfolio is not draining your cash flow.
I know many financial planners suggest you should go into retirement with no debt at all, but in my mind entering retirement with a conservative amount of leverage works well for those investors who have set themselves up correctly.
These investors often live off their superannuation assets and income for the first 10- 15 years of their retirement allowing their property portfolio to once again double in value which allows their already low loan to value ratio to fall even further enabling their property portfolio to spin off even more cash flow.
Others achieve their cash flow in retirement through the dividends from shares or from the positive cash flow of commercial property investments.
So how do I transition to the cash flow phase of my investing?
Grow your portfolio at a slower pace
- Once you’ve grown a substantial asset base, one option is to slow down the pace at which you grow your property portfolio.
- Convert to a principal and interest loan
- As you transition to the cash flow phase of your investing, you could convert some of your loans to principal and interest, allowing your tenants to slowly pay off your mortgages, thereby putting you in a stronger cash flow position. Remember that while paying interest on investment loans is tax-deductible, paying off the principal portion of the loan is not.
- Sell a property or two and repay debt
- You know I prefer to hold properties for the long term, but the purpose of owning these properties is to give you the lifestyle you want. This means sometimes the right thing to do is sell off one or two investments and use the proceeds to reduce your portfolio debt and increase your cash flow.
- Investing in commercial properties.
- Different from residential real estate, commercial properties tend to have strong cash flow but less capital growth. So, adding commercial properties to your portfolio once you already have a strong asset base may be appropriate for you.
- Use part of your Super or savings to pay off debt
- Redevelop a property or two to repay debt
Some property strategists put together 40-year spreadsheets as part of their plan for their clients. Why doesn’t Metropole do that?
Our plan is a lot more than just spreadsheets are numbers and figures. Even though it does contain detailed numbers and projections.
Of course, we know there are a myriad of different factors that will affect your wealth journey including factors out of your control and factors within your control.
Your life circumstances will change, interest rates will change, inflation will change and your ability to obtain finance (one of the most important factors of all) will change over time.
Then every year there will be an X factor, and we have learned all too well that every decade or so the economy “breaks.”
So rather than giving you a false sense of security I having very detailed long-term spreadsheets, we break down your goals into shorter timeframes and then regularly, usually annually, review your situation to make sure you’re heading in the right direction.
How big a financial buffer do I need?
Beginning investors can’t really afford much of a buffer all, it’s better to use their cash to increase their deposit and get into the property market, and then they should save their spare money, often putting it into the offset account, and create a buffer.
Your buffer is there to cover unexpected expenses, and by definition, if they are unexpected, you won’t really know how much you really need.
Some things to consider are:
- What is your current monthly cash flow surplus, in other words, how much are you able to save (your income minus all your expenses)
- Can you cover the current cash flow shortfall for your investment property?
- Are you able to fund the cash flow shortage in between tenancies when there will be no rental income for a couple of weeks plus you’re managing agents letting fee?
- Will you be able to fund unexpected repairs or maintenance?
- Could you find a rising interest-rates?
- How secure is your job, and are you able to increase your income by doing extra shifts or seeing extra clients, customers, or patients?
Concentration or diversification – which makes better investments?
Common wisdom seems to suggest that you should diversify your investments.
But is this correct?
You will find many financial planners telling you to diversify for your own protection.
What they fail to tell you is that it is also for their protection.
Warren Buffett, one of the world's greatest investors, said, "Diversification is a protection against ignorance. It makes very little sense for those who know what they are doing."
Instead of diversifying, strategic investors focus on finding the best investments.
In my mind diversification leads to averageness - bottom of the best and cream of the bottom.
In my experience, I’ve found that wealthy and successful people - be they a businessperson, entrepreneur, or investor - have one in common: they specialize.
One of the reasons the rich get richer is because they are focusing, while the middle class is diversifying, and the poor are counting on the pension.
First, they concentrate, then they reinvest
Another thing the successful people all had in common was that they reinvested the money they “earned” from that one activity into passive investments – most often real estate.
They kept building their asset base so that it would one day provide them "unearned income" - income they do not have to work for.
The lesson from this is to specialize and concentrate your activities on something you can become good at.
However, as your portfolio grows in size here are some areas where you can diversify:
- Diversify lenders - just as banks worry about "concentration risk" if they have lent you money for "too many properties", it doesn't make sense to have lender loyalty - spread your risks by using a number of banks
- Diversify loan terms and types - protect yourself from interest rate fluctuations by having some loans fixed and some with variable interest rates. if you only have one loan you can split it into both fixed and variable in most cases
- Diversify your investments across different states to take advantage of their individual cycles
- Tenant and property types – over time you should own residential, commercial and industrial properties, apartments and townhouses
Metropole’s Strategic Property Plan – to help both beginning and experienced investors
“If you’re wanting to live purely off your rentals, you’re going to have to get a big enough cash machine, which may mean 5, 6 million dollar’s worth of property with no mortgage.” – Michael Yardney
“Since most financial advisors cannot tell you exactly which share or managed fund is a great investment, they tell you to buy a bunch of them.” – Michael Yardney
“What’s happening now won’t go on forever. A chapter in your life is not the whole story.” – Michael Yardney
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